Monday 1 August 2011 15.55 EDT
First published on Monday 1 August 2011 15.55 EDT

The International Monetary Fund's UK expert has said the government should be ready to cut taxes and boost the supply of money if Britain's flagging economy suffers a prolonged period of weak growth, high unemployment and low inflation.

On the day that the monthly health check of manufacturing showed the sector sinking back into recession for the first time in two years, Ajai Chopra warned that ministers would need to be nimble if the economy performed less well than the IMF has been anticipating.

Chopra, who led the IMF's mission to the UK for its annual assessment earlier this year, said the IMF still believed the UK was on course for a gradual recovery despite the headwinds caused by a soft housing market, George Osborne's budget measures and the desire of consumers to pay down debt.

Chopra said in a blog: "The UK government should be nimble in its policy response if it looks as though the economy is headed for a prolonged period of weak growth, high unemployment and subdued inflation.

"Currently, we don't expect this to happen. But if such a scenario appears to be in prospect, we recommend responding quickly with some combination of further quantitative easing by the Bank of England and temporary tax cuts."

Analysts in the City said a second dose of quantitative easing from the Bank of England looks more likely following the downbeat news from industry, where companies are starting to shed jobs in response to weakening domestic order books. Most agreed with Chopra's view that the UK was set for a "choppy and bumpy" recovery.

Mark Lee, head of manufacturing at Barclays Corporate, said: "Very weak domestic demand has effectively stalled any momentum that had built in the UK manufacturing sector over the past two years, with these new figures highlighting a worrying trend of destocking among manufacturers, as they seemingly prepare for further declines in orders.

"Manufacturers that export continue to see some upside in ongoing sterling weakness, but for those companies focused on the domestic market there is very little relief in sight at present."

Figures released last week showed UK output growing by just 0.2% in the three months to June, and analysts said there were now doubts whether the pace would accelerate in the third quarter. Until recently, manufacturing had been a bright spot, helped by the pickup in world trade and the fall in the value of sterling.

Richard Driver, analyst for Caxton FX, said: "This manufacturing figure is alarmingly poor and really consolidates negative market sentiment towards the UK economy. The data undershot expectations considerably and represents the worst showing seen from the sector in over two years. This could represent the UK economy's first step back into recessionary territory; forward-looking data suggests that data is going to continue to get worse over coming months.

"These sorts of figures make further quantitative easing more likely than a Bank of England rate rise. To hike rates with UK growth at these sorts of levels would be self-destructive, regardless of high inflation."

Britain was not the only country to see its manufacturing performance weaken last month, with the PMIs for the eurozone and US also recording sharp falls in activity. But George Buckley, UK chief economist at Deutsche Bank, said only Sweden, Australia, Switzerland, Israel and Taiwan had suffered a more pronounced decline in manufacturing this year than Britain, adding: "In many of those cases this reflects the fact that they peaked at higher levels than the UK."